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The U.C.C. As A "Tool" For Procurement Professionals - Part II

Author(s):

Ernest G. Gabbard, J.D., C.P.M., C.P.C.M.
Ernest G. Gabbard, J.D., C.P.M., C.P.C.M., Director - Corporate Procurement Teledyne, Inc., Los Angeles, CA 90067, 310/551-4220

81st Annual International Conference Proceedings - 1996 - Chicago, IL

The Issue.
Today's complex procurement environment demands a working knowledge of many specialized disciplines. One of the more complex of these is commercial law. This workshop will summarize relevant legal principles which affect the modern procurement professional. It will also demonstrate how these principles can be valuable "tools" in the drafting, negotiation, and management of purchasing transactions.

This summary is a "sequel" to last year's program and will be presented in the following sections:

  1. Contract Formation - Review
  2. Acceptance/Rejection of Goods
  3. Remedies for Breach of Contract

Each one of these sections is a subject about which one could write volumes. However, it is my intention to address only those aspects of each which are of particular significance to the procurement professional.

1) Contract Formation. Let me first assure you that the old triumvirate of offer, acceptance and consideration are still required for contract formation; however, at the risk of offending my attorney colleagues, let me assert that they are almost rhetorical requirements under modern commercial law. This is because modern courts recognize the importance of certainty in commercial transactions, and they will therefore "stretch" legal principles to find the elements of a contract wherever possible. Consequently, we will not spend time on those issues in this workshop.

Perhaps the most problematic aspect of contract formation is that of written versus oral contracts, i.e. when must a contract be in writing to be enforceable? While the rules do vary from state-to-state, they generally require a written agreement for the following contracts:

  1. Sale of goods over $500
  2. Promise to pay debt of another
  3. Sale of land or interest therein
  4. Contracts not performed within one year
  5. In consideration of marriage

The "exception" to these general rules is when a contract has been fully or partially performed, and the circumstances necessitate recognition of a contract to avoid an unjust result. HOWEVER, more important than this exception is the modern (UCC) concept that a contract can be found to exist where there was nothing more than an exchange of correspondence between the parties. This concept will be reviewed during our workshop.

In the process of contract formation, we must determine what terms and conditions (T&C) will govern our procurement transaction. The significance of clearly establishing the T&C at this stage cannot be overemphasized, as these T&C will govern the entire life of our transaction(s). Last year, we analyzed this concept in detail; however, this year we will touch on the following aspects: a) General principle - Contracts include both express and implied terms & conditions, i.e. there is more to a contract than what is written therein. We will explore the ramifications of this principle during our workshop. However, in the interest of covering additional subjects, we will not be able to spend much time on the subject this year. b) Minimum requirements - many attendees last year requested some examples of the clauses we discussed in our minimum requirements section. The summary of these "minimum requirements" is provided as Attachment A. Examples thereof cannot be provided herein due to space limitations. However, we will discuss these "minimum" T&C and provide examples during our workshop.

2) Contract Performance. This is an area which would require volumes to cover adequately; however, my experience indicates that the most significant problem area of this subject for the procurement professional is that of "acceptance" of goods. This particular subject is one which the Buyer needs to understand so that he/she can avoid problems, and can "educate" other personnel who affect the acceptance process. To summarize the issues: a. Buying companies often fail to effectively reject non-conforming goods in a timely manner, due to the assumption that "acceptance" requires an overt act on their part. However, UCC 2-605 and 2-606 establish that "acceptance" of goods will occur if a Buyer fails to object (in a timely manner), or if the Buyer acts in a manner inconsistent with non-acceptance of goods. Therefore, it is important that goods be inspected immediately, and that a timely notification of objection or rejection be provided to the Seller for any deficiencies discovered during the acceptance process. b. UCC 2-607 provides that the effect of failure to reject non-conforming goods in a timely manner is that: 1) Buyer must pay the Seller; and 2) Buyer must now assert contract breach - rather than merely non-acceptance. This latter element also requires that Buyer now prove that the non-conformity "substantially impairs" the value of the goods.

These are not desirable prospects for a Buyer or his/her company; therefore steps should be taken to protect against inadvertent acceptance of material or services. We will discuss this in depth during our workshop.

3) Breach of Contract. The question Buyers most frequently ask on this subject is whether they must wait for a Buyer to fail to perform (breach) if they know or believe that performance will not be forthcoming. The answer is that the law generally allows either party "the full time bargained for" to perform their respective contractual obligations. HOWEVER, UCC 2-609 and 2-610 provide that the Buyer may request "reasonable assurance" of performance whenever the circumstances indicate a breach is probable, or the other party declines to perform (repudiates) its obligations. This is a remedy of which most Buyers are unaware, and is available to Buyers at any stage in the procurement process.

The next most frequently-asked question is whether the Buyer can "terminate" the contract (P.O.) in the event that Buyer breaches or fails to perform. Unfortunately, there is not a clear answer. While the UCC does allow termination for breach, the enforceability of such a termination is dependent upon the circumstances surrounding the transaction and the breach. As a general rule, the Buyer should ensure that a "termination" clause is included in the T&C to clearly establish the termination rights of the Buyer. In the absence of such a clause, the Buyer must exercise caution, and not react imprudently. i.e.: If the Seller's breach is classified as "minor", termination by Buyer would be inappropriate; however, if the breach is "material", Buyer should exercise its reasonable right to terminate and reprocure elsewhere. We will discuss this materiality element during our workshop.

We covered the area of contract breach in depth during our workshop last year; however, attendees requested a discussion of the "remedies" available to a Buyer for a breach of contract by a Seller. This subject will therefore be covered this year. Remedies can be summarized as follows: a. The basic rule of remedies in a breach of contract case is that the breaching party must make the non-breaching party "whole". This essentially precludes the Buyer from obtaining penalties from the Seller for a contract breach. It also means that Buyer must carefully document any damages for which Buyer intends to recover from Seller. b. The primary remedy for failure to perform a contractual obligation in a timely manner is the Buyer's right to "cover" - procure elsewhere, and recover any excess costs from the Seller. This right requires timely action by Buyer, and is subject to reasonable limitations, such as the Buyer's duty to "mitigate" (minimize) damages caused by Seller's breach. c. In addition to the basic right to recover excess costs of reprocurement, Buyers may also be entitled to incidental and consequential damages under UCC 2-715. These are the ones Sellers try so hard to avoid by objecting to them in acceptance of Buyer's P.O. To summarize these two types of damages:

1) Incidental - These include any financial damages which result somewhat "directly" from Seller's breach, e.g. Buyer is unable to operate its manufacturing line, which results in lost productivity for Buyer's factory.

2) Consequential - These are the more "indirect" damages, which Sellers try to avoid, because they can be so extensive and can far exceed even the contract value. e.g.: Seller's failure to deliver, results in Buyer's inability to run its manufacturing facility, which results in damages to Buyer's customers. Even remotely related damages can be recovered under these provisions. d. Any review of contractual remedies would be incomplete without a discussion of "liquidated" damages. The term "liquidated" essentially means agreed upon, and usually represents Buyer's and Seller's attempts to pre-establish the cost to Buyer of Seller's failure to perform. The danger in these clauses is that Buyers often attempt to disguise "penalties" in a clause entitled "liquidated damages". Courts will not enforce such clauses unless they represent only the probable cost to Buyer of Seller's breach. This is often difficult to accomplish in advance of an actual breach. We will discuss the distinction between liquidated and punitive damages during our workshop.

Conclusion.
The subject of commercial law in a procurement transaction is extremely complex, and has just been touched-upon in this presentation. It is anticipated that some of the rules outlined herein will become valuable "tools" for the Buyer to utilize in the exercise of his/her professional responsibilities. It is also hoped that an understanding of these basic elements will motivate the Buyer to obtain additional information on this subject.

Terms And Conditions (Minimum)

  • Acceptance (Of Order) - Limit To T&C Of Order; Object To Any Proposed Deviations
  • Delivery - Assert "Time Is Of The Essence" In R.F.P. And P.O.
  • Inspection/Acceptance (Of Goods) - No Acceptance Until Inspection
  • Warranties
    • Assert Express Warranty Requirements
    • Reaffirm Implied Warranties
  • Changes
    • Reserve Reasonable Right To Make Changes In Specification, Quantities Or Delivery
  • Prices - Affirm Prices Include All Elements, Including Taxes, Duties, Etc.
  • Payments - Tie To "Acceptance" Of Goods If Possible
  • Indemnification - Obtain Appropriate Language From Company Legal Counsel
  • Assignment - Require Prior Approval Of Assignment Or Subcontracting
  • Termination
    • Affirm Right To Terminate For Default "As Provided By Law"
    • Establish Reasonable Right To Terminate For Convenience Choice Of Law
  • Utilize The State Law Of Your Company Where Possible
  • Disputes - Provide For Alternate Resolution To Avoid Courts Of Law (My Opinion)
  • Integration - Supersede All Prior Or Contemporaneous Discussions Or Correspondence.

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